Syngenta (SYT) – Merger Arbitrage – 17% upside

Current Price –$79.34

Offer Price - $93

Upside – 17.5%

Expiration Date - TBD (likely in H1 2017)

Let me start by saying that this is a large cap transaction and the deal is widely followed and analysed – I do not have any superior insights with regards to the likelihood of the transaction going through so my opinion is as good as anybody’s else. However, I believe this opportunity is quite interesting, spread is large (17%) and therefore worth flagging.

Background

In Feb 2016 ChemChina agreed to acquire Syngenta at $93 per Syngenta ADS. Syngenta operates in crop protection and seed businesses – industries which are lately subject to other mega M&A deals including Dow Chemical and DuPont merger as well as Bayer’s acquisition of Monsanto.

ChemChina is Chinese state owned company so this transaction has national strategic interest written all over it. This would also be the biggest ever overseas acquisition by Chinese firm. So besides any financial pay-off/valuation considerations, ChemChina obviously has other motives to get this transaction closed.

The deal has already been approved by a number of national regulators including those of United States, China, Japan, Switzerland, Australia, South Africa and Israel. After US approval (August 2016) the spread has narrowed to single digits, but has widened again since. Also the financing for the transaction has been arranged and is irrevocable.

Reasons for 17% spread

There are three main factors behind the 17% spread and market’s skepticism with regards to the likelihood of transaction going through.

1) The main reason is the pending anti-trust approval by European Commission. The commission has launched in-depth review that has been extended to March 29th, 2017 (more on that here). I think approvals by other regulators globally provide at least some comfort with regards to expected EU decision. European Commission is also unlikely to deny the transaction outright, but probably will ask to divest certain businesses to maintain competitive markets for Syngenta products. At the same time ChemChina has repeatedly expressed willingness to work with EU regulator to find acceptable form of transaction.

2) In the beginning of December China’s government has announced that it will start rigorously regulating outward fund flows including those for M&A deals. This article provides a good overview of the situation. Market is clearly concerned that the merger might simply be banned by Chinese due to these new restrictions on outbound direct investment. My think is that merger of such scale (record outward investment for China so far) already has full support from the authorities and new regulation will be an issue.

3) Syngenta operating performance over the last couple of quarters has been below expectations. I do not believe that this anyhow affects ChemChina’s willingness to acquire Syngenta – ChemChina would be strategic long term investor and short term performance is clearly of no concern. However, if the deal breaks, Syngenta would likely trade lower as a standalone company.

Downside Risk

Right before the acquisition announcement Syngenta traded around $70/share, but rumors about potential merger started spreading earlier in Autumn 2015 – pre-rummor Syngenta share price was c. $65. If the deal breaks, Syngenta will probably trade down to these levels, or potentially lower due recent operating performance. On a positive note, the whole sector is consolidating and Syngenta will probably remain an acquisition target – Monsanto wanted to buy it in 2015 and BASF was rumored to be a potential suitor as well. All in all, I expect Syngenta to trade somewhere around $65-$70/share if the deal breaks, representing 11%-17% downside.

Thus downside and upside are quite similar for this transaction, suggesting market is seeing the probability of deal closing at c. 50%.

Due to reasons outline above (large cap deal where I have no specific insight) I have only a tiny long SYT position.

12 COMMENTS

there are more concerns than #1 and #2. The mainstream Chinese banks have not stepped up to finance the transaction, raising the money is an issue. There was a rumor ChemChina was going to get taken over by a rival, though that appears to have been squelched. Its unclear with the new Chinese government rules on M&A currency outflows whether or not the government truly supports the deal. The deal may go through but it has a large amount of geopolitical risk and in China you have to read between the lines, its never explicit on their intentions or concerns.

Work 22. Thanks for commenting. I have never said that one #1 and #2 are the only concerns, but in my opinion these are the main ones causing the wide spread.

Re financing – financing for the deal has already been agreed and clearly articulated in the offering document. You might be referring to post-deal financing to take off the bridge loans. My thinking is that if the deal goes through, then one way or another post-deal financiers will be found – after all ChemChina and mainstream Chinese banks are owned by the same government. Or are you referring to something else?

Re merger with Sinochem – even if rumors turn out to be correct, I do not see why that should affect global expansion ambitions of the joined company. Government is the key driver behind this M&A and having Sinochem and ChemChina merging into one should not make Syngenta any less attractive from government’s perspective. Also I expect SYT deal to close in the upcoming quarters and any merger between Sinochem/ChemChina would probably take at least a year to finalize.

Re Chinese intention. I disagree with your point that it is not clear whether government supports the deal. ChemChina is state owned company, so if ChemChina wants to acquire SYT it means Chinese government wants to acquire SYT. This type of high profile international deal could never be envision without full support of Chinese government. So I actually see a very low likelihood of ChemChina walking away from the deal.

I agree the deal probably gets done, but there is a LOT of hair on it and my points were to illustrate that there is darn good reason for this wide spread. Its more of a coin flip than we want to think. I posted a couple Bloomberg articles further below as well. The Sinochem CEO had wanted Syngenta for himself, but lost out. He may have been trying to takeover Chemchina as a way to thwart his rival and get the Syngenta deal back. Not sure, its not clear in China. Chemchina is government owned but there are different factions owning different companies there- they do not all speak with one voice. That is a major misconception amongst Westerners. Sure the deal is in China’s best interest, but China has been throttled back on any capital leaving the country, and this deal might be part of that policy– we simply do not know. Do they make an exception to the new FX capital control policy for seeds or not? The Chinese do not communicate very directly and clearly on these subjects unfortunately for arbitrageurs. The mainstream Chinese banks may not be permitted to support the deal. Thus the wide spread. Don’t forget the Trump vs. China saga- the deal needs US approval. Anyway, you see my point- lots of good reasons the deal is a wide spread and the downside is still significant.

Some Bloomberg articles from December:

(Bloomberg) — ChemChina is seeking consent from lenders on its $12.7b loan to postpone the deadline for registering China National Chemical Corp. as a guarantor under the loan with China’s State Administration of Foreign Exchange (SAFE). Deadline is being amended to Feb. 2017 from Dec. 25, 2016 Consent from at least two-third of lenders is needed for the amendment No amendment fee is offered ChemChina representatives could not immediately be reached for comments when contacted by phone and e-mail today NOTE: Sept. 6: The $12.7 bridge loan, provided by 17 banks, backs ChemChina’s acquisition of Syngenta Information from people familiar with the matter, who are not authorized to speak publicly and asked not to be identified Related stories: Dec. 1: ChemChina said to set up $5b fund for Syngenta bid: Basis Point Nov. 16: ChemChina gets Baa2 rating from Moody’s; outlook negative Jul. 12: ChemChina said to plan $10b stock sale backing Syngenta deal

also:

(Bloomberg) — Syngenta upgraded to strong buy from outperform; ChemChina deal has high probability of a successful closing, Raymond James analyst Patrick Lambert writes. Confident on deal closing as it doesn’t fundamentally change competitive landscape, strategic importance of this deal for ChemChina to modernize Chinese agriculture Deal now needs U.S. and EU approval, which should be coming in 1Q or 2Q of 2017 NOTE: Dec. 8, Syngenta Confident on Purchase by ChemChina, CEO Tells Le Temps (Link) Dec. 7, Australian Regulator Won’t Oppose ChemChina’s Buy of Syngenta (Link)

Thanks for elaborating. I think we are in agreement that deal is risky and that there are reasons for the spread to exist. I am definitely not claiming to be smarter than all the M&A arbitrageurs out there. You talk about still pending US approval – to my info that has already been received in Aug 2016 – are you suggesting something different here?

CFIUS approval was received in late August 2016, but US antitrust has not yet been cleared (they are working with the EU) as far as I see. Now most everyone agrees that US antitrust isn’t an issue, but it could be the lever Trump pulls if he decides he doesn’t like this deal. Any deal (battle) with China is arguably at risk because of the greater trade policy conflict (the war) between Trump and China. Everything would change if Sinochem took over Chemchina, and everything changes for all Chinese deals come January 20th. US approval, despite the CFIUS blessing, is not set in stone. What do you think Trump would say if asked about this deal?

As a friend of mine who worked in China explained to me: “A signed contract is not a guarantee in China. Relationships are key, if we no longer get along, the contract is meaningless to them. The deal is the start and we progress from there.” Obviously different than a western mentality!

To be clear, since email and comment writing is so difficult to discern tone, I am very appreciative of the site and your ideas, I just wanted to point out the extra risks specifically in this Syngenta trade in comparison to odd lots etc. I did have a position but took it off because the downside was still too high. Still probably greater than 50/50 chance deal gets done, but $14 upside versus maybe $10 downside (guestimate of course) is tough. I prefer many of your other ideas

Work 22, your input is very much appreciated, so keep the critical comments coming. Thanks for clarifying on US antitrust, I thought it is already in the bag. Agreed on the risks re China – we will see if political pressures/emotions will overshadow economic/strategic interests. SYT is a not US company, so China – US relations might be less important in this case.

Like you, I prefer other ideas more, which is the reason for smaller than usual position in SYT.

Another delay. Now till the 12th of April. Apparently Syngenta and ChemChina themselves asked for this extension, so really not sure whether this is a positive or a negative. On one hand it is clear that the companies have not reached acceptable deal with the regulator yet and need more time to work it out (how do they now 3 months in advance that 2 more weeks are necessary is beyond me, maybe related to some kind of timelines for regulator). On the other hand, they seem to be willing to compromise to get regulator’s approval. In any case, just guessing and speculating at the moment.

I have decided to close my SYT position. The stock has advanced 9.5% in three weeks, which is a great return. The spread has narrowed from 17.5% to 7% – but all the risks are still there: EU approval and China capital outflows. These approvals might take couple more months.

Having seen what happened to RAD/WBA merger, I am taking my profits and moving on.